Raines escapes brunt of Fannie Mae inquiry

Marcy Gordon, The Associated Press

Published 10:00 pm, Thursday, February 23, 2006

WASHINGTON -- An extensive investigation of embattled Fannie Mae points to its former finance chief and controller as mainly responsible for the accounting failures at the mortgage giant now struggling to emerge from an $11 billion scandal, according to a report released Thursday.

The report, by a team of investigators led by former Sen. Warren Rudman of New Hampshire, also found that former Chairman and CEO Franklin Raines, while not sharing direct responsibility, contributed to a culture of arrogance at the government-sponsored company. The report comes about 17 months after the revelation that federal regulators had discovered violations of accounting rules and earnings manipulation by the company to meet Wall Street targets.

The board of Fannie Mae, which finances one of every five home-mortgage loans in the United States, hired Rudman as independent counsel to launch an investigation at the time of the stunning disclosures in September 2004.

Fannie Mae executives, especially former Chief Financial Officer Timothy Howard, gave the board incomplete and sometimes misleading information regarding the company's accounting and finances, the report found. Howard and longtime CEO Raines were ousted by the board in December 2004.

The report also concluded that Howard and former Controller Leanne Spencer, who resigned last year, "were primarily responsible" for the flawed accounting practices in their overzealous drive to allow the company to show smooth earnings growth and meet Wall Street analysts' expectations.

The highly critical September 2004 report by the regulators also singled out Howard, saying he "failed to provide adequate oversight" -- a charge he has denied.

As for former Seattleite Raines, who was one of the most influential and politically savvy figures in Washington, D.C., the Rudman investigation did not find that he knew that Fannie Mae's accounting practices violated rules.

"We did find, however, that Raines contributed to a culture that improperly stressed stable earnings growth and that ... he was ultimately responsible for the failures that occurred on his watch," the report says.

A 1998 instance in which Fannie Mae was said to have improperly put off accounting for $200 million in expenses to future periods so top executives could collect $27 million in bonuses -- previously made public -- was affirmed by Rudman's inquiry. Documents cited in the report show that top-level management was focused in 1998 on the $200 million "catch-up" and meeting earnings targets that would trigger the payment of full bonuses.

A federal regulator has said that Fannie Mae employees falsified signatures on accounting transactions that helped the company meet the 1998 earnings targets.

The Bush administration, which has criticized Fannie Mae and Freddie Mac, its smaller rival in the $8 trillion home-mortgage market, quickly cited the report's findings as buttressing its view that Congress should reduce their huge mortgage portfolios.

"The Rudman report lays bare the earnings-at-any-cost culture that had developed over many years at Fannie Mae and the substantial abuses that resulted," Treasury Undersecretary Randy Quarles said in a statement. "A principal vehicle for generating these earnings was the enormous growth in the portfolio of retained mortgages, and that remains the principal legacy of this decade of abuse."

Fannie Mae shares rose $1.23, or 2.2 percent, to close at $57.14 on the New York Stock Exchange, reflecting investors' relief that the Rudman investigation had found no major new problems and had noted a "dramatic" improvement in Fannie Mae's corporate culture and internal organization under the current management.

Raines' attorney, Robert Barnett, took issue with the report's characterization of his client's role in Fannie Mae's corporate culture.

"Throughout his tenure, Mr. Raines sought to create a leadership culture that focused on openness and good governance," Barnett said in a statement. At the same time, having publicly promised to hold himself accountable for what happened at the company, Raines accepted the report's statement concerning his responsibility, Barnett said.

Steven Salky, a lawyer representing Howard, said: "Tim Howard consistently acted in accordance with the highest standards of integrity and in the best interests of shareholders. We reject the report's mischaracterization of Mr. Howard's motives and conduct."

Spencer couldn't be reached for comment.

Howard and Raines defended the company's accounting in testimony at a congressional hearing in October 2004, rejecting allegations of accounting improprieties and management misdeeds going back to the late 1990s.

Howard and Raines have certified in sworn written statements the accuracy of Fannie Mae's financial results during the period in question, 2001-2004. They would have violated a law had they been aware of the accounting improprieties when they signed off.

Daniel Mudd, Fannie Mae's chief executive, called the report "strong but good medicine."

"Fannie Mae is a different company than a year ago," Mudd said in a statement. "We have been humbled, even embarrassed. But we have begun to make significant changes."